EXPLORING ALTERNATIVE
INVESTMENTS

For those keen to explore beyond traditional stocks and bonds, the world of alternative investments may present some different opportunities. This article will guide you through various options for investment, including: real estate, commodities, hedge funds and private equity, illustrating how they can diversify your investments.

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The alternative investment sector encompasses a wide range of asset type, each with unique characteristics that need to be understood. However, the potential benefits in terms of portfolio diversification and potential returns — make researching the opportunities worthwhile. Here is what you need to know about researching, finding and purchasing alternative investments.

What are alternative investments?

Alternative investments are assets that are not stocks, bonds or cash. Almost anything that can be bought and sold can be considered an alternative investment, but popular markets for investors who already have holdings in traditional investments include commodities, real estate, private equity vehicles, hedge funds, structured products, collectibles such as antiques, and cryptoassets.

Types of alternative investments

An extensive range of alternative investments are available to trade, and each of the asset classes offers something different to an investor.

Commodities

Most brokers offer markets in hard and soft commodities ranging from copper and gold to cotton and soybeans. Prices of commodities are strongly influenced by long-term macroeconomic cycles and supply and demand constraints. Freak weather events can also drive price movement, which is often uncorrelated to price movement in bonds and stocks.

Real estate

Property assets can be bought outright by an individual, but there are various other ways to gain exposure to the real estate market. One popular example is through real estate funds, which are listed on exchanges and offer great convenience. These usually contain a basket of different underlying assets, which ensures that there is a degree of built-in diversification.

Private equity 

Private equity funds buy and operate companies before selling them on to a broader market by listing them on a stock exchange. Taking away the need to address short-term shareholder concerns allows private equity funds to implement significant long-term changes to operating practices, which aim to drive up the value of the asset.

Hedge funds

Hedge funds have traditionally aimed to generate a positive P&L return regardless of whether the broader market goes up or down in value. 

Using techniques such as short selling to give their strategies a market-neutral approach can mean that some upside is forsaken during years when stock markets rally, but offers a degree of insurance during periods when stock prices plummet.

Structured products

These specialist investment vehicles are created by banks and include a basket of assets designed to serve a particular investment aim. They are similar to bonds and dividend stocks in that they pay investors a regular dividend, but also have a derivative element factored into their pricing. 

Collectibles 

Physical items such as antiques, fine wine, art, stamps, racehorses and vintage cars are all widely traded. Investors in these items may derive some value from holding a prized asset and could potentially make a financial return if the value of the asset increases.

Cryptoassets

Digital assets, including large-cap cryptocurrencies such as Bitcoin and altcoins such as Dogecoin, use blockchain technology to secure transactions, control the creation of new units, and prove asset ownership. 

While cryptoassets are becoming more mainstream, with institutional adoption growing over time, the market remains highly volatile and factors that drive price movement still differ from typical elements of fundamental analysis that determine the prices of most traditional investments.

Why consider alternative investments?

The risk disclaimer that can be applied to many alternative investments is that they are relatively high-risk assets that can suffer dramatic falls in value. While alternative assets have a higher risk potential, they also present more potential opportunities for investors to make significant returns on one position. 

Another reason why alternative assets could complement your portfolio is that they offer a degree of diversification. The price moves in some assets are uncorrelated, or negatively correlated to price moves in stocks and bonds. Allocating a percentage of your available capital to alternative assets could see moves in your total portfolio P&L balanced out by alt assets rising in price when bond and stock markets fall. 

Not only is this beneficial in cash terms, but also a portfolio with lower levels of price volatility is easier to manage.

Benefits and risks of alternative investments

All investing comes with a degree of risk: alternative investments are no different from more traditional markets. There are some risks that are specific to the alternative investment sector as a whole, and some that specifically relate to a particular group of alternative assets.

Benefits	Risks
Portfolio diversification:  Alternative investments offer a way to diversify your portfolio, with different asset groups balancing each other to mitigate market risk and reduce emotional trading based on short-term price shocks.	Knowledge gap: Newcomers to alternative investing must invest time to understand their investment choices, including trade management and develop strategies to maintain positions over trade lifespans.
Unique offerings: Alternative investments offer potential that may not be found in traditional investments.  For example, some crypto traders have made life-changing returns from a single investment in a low-cap cryptocurrency that then rallied in a bull market; a scenario unlikely with traditional investments.	Tax treatment: Government tax-efficient schemes typically cater to mainstream assets such as stocks and bonds, excluding many alternative assets from such benefits.
Inflation hedge: Certain alternative investments (such as real estate and commodities) can hedge against inflation by increasing in value with inflationary pressures.	Liquidity: Alternative markets often have lower liquidity due to lower trade volumes, resulting in wider bid-offer spreads. This can make it difficult to find buyers, especially for bespoke instruments.
Flexibility: Alternative investments offer flexible structures, allowing for direct ownership, pooled funds, or specialized vehicles to accommodate diverse investment preferences and objectives.	Research: Popular markets such as stocks including Tesla, Amazon and Nvidia receive more media attention and have abundant research materials available, making it easier to stay informed about developments impacting their value.
Innovation: Alternative investments involve emerging sectors and technologies often underrepresented in traditional markets, providing opportunities to capitalize on future trends and innovations.	Eligibility: Certain alternative assets impose strict eligibility criteria (such as minimum investment), which limits who is able to invest in them.

Risk mitigation with alternative investments

After identifying the benefits and risks of alternative investments, it’s crucial to consider how you might mitigate the risks attached.

Diversification

Allocate capital across various positions to reduce the risk of losing all of your investment in one area. Spreading exposure helps to mitigate potential losses.

• Sector diversification: Consider your total exposure to alternative markets. The savviest investors typically allocate 15-30% of their capital to this sector, starting smaller for newcomers.
• Asset class diversification: Diversify cash across different alternative investment areas (such as investing in private equity, commodities, crypto and real estate) instead of concentrating on just one.

Investment horizon

Factor in your preferred investment timeline. Some alternative investments take years to mature, and exiting early could result in losses. Moreover, some alternative investments are tied to long-term market cycles or broader macroeconomic conditions. 

How to incorporate alternative investments into your portfolio

The basic rules relating to the implementation of any new strategy are: do your research, diversify, and always keep your overall investment strategy in mind. Investing in alternative assets is no different, and it is important to remember this before parting with any capital.

While many alternative assets are not tradable online, for those that are, selecting the right broker is key. Look for one offering exposure to a broad range of markets, including a combination of commodities, real estate funds and cryptoassets.

By including alternative investments in your overall portfolio, you will develop a more macro-focused approach. Your portfolio will be less influenced by the bullish and bearish trends common in stock and bond markets, and more influenced by long-term economic factors.

Evaluating the performance of your investments requires a different approach compared to traditional investments:

• Return on investment (ROI): Unlike stocks, where price changes are evident, determining ROI for alternative assets can be challenging. Investors often assess overall P&L returns to gauge potential gains.
• Volatility: Consider P&L volatility to understand how returns fluctuate. High volatility might indicate significant price swings, which may not suit your risk appetite.
• Holding period: Determine the expected holding period for each investment. This helps to filter alternative assets that align (or don’t align) with your investment approach.

By adhering to these principles and monitoring your investments carefully, you can effectively include alternative assets in your investment strategy.

Final thoughts

By nature, the alternative investment sector is very broad and some assets included in it are complex, high-risk propositions. But, assets in the group do commonly share two characteristics: firstly, they offer a way to improve the level of diversification in your portfolio, and secondly, they present the chance to post exceptional gains.

As always, a well-researched plan and investment strategy is essential for successful investing. Some extra care is needed when choosing exactly which assets to buy, but for those investors who already have a well-thought-out and balanced portfolio, alternative investments might present an opportunity to take strategy planning to the next level.

Use the eToro Academy to learn more about investing in alternative assets.

Quiz

FAQs

How do alternative investments differ from traditional investments?

Alternative investments include assets that experience price moves that are different in nature and direction from traditional investments such as equities, bonds and cash. Some markets in alternative investments are known for low levels of liquidity and higher operational fees.

What factors should be considered when investing in alternative assets?

Alternative assets need to be treated with care and respect. Your risk management protocols will need to factor in the likelihood of increased price volatility, and it’s not only a case of finding a good idea, but finding one that suits your investment time horizon and can help you to achieve your financial goals.

How can investors start incorporating alternative investments into their portfolios?

Some of the asset groups in the alternative investment sector can be traded through an online broker. They can even be traded in a risk-free demo account before being taken into a live environment. Other alternative investments such as art are traded away from exchanges and held in physical form.